The Weight on the Dollar

The week's two main themes, political unrest in Northern Africa and the Middle East and rate hike speculation have joined forces and is serving to undermine the greenback. The surge in oil prices appears to be shifting the finely balanced outlook for interest rates in favor of tightening, while the Federal Reserve remains committed to easing of monetary policy through its Treasury purchases.

The contrast between the hawkish rhetoric by ECB officials and the dovish remarks of the Fed's Evan yesterday who opined that the improved growth prospects should not spur the Fed into hiking rates, could not be starker. Over the past five days, short-term interest rate differentials have moved decidedly against the dollar. The 2-year US-German spread has moved 25 bp against the dollar over the past week, while the US-Japanese and US-UK 2-year spreads have moved about 15 bp against the greenback.

In the UK, the Bank of England minutes showed a 6-3 vote in favor of leaving rates steady, but not quite in the way the market expected. The speculation was that the Deputy Governor Bean joined the hawk camp, but this provided untrue. The BOE's head economist Dale voted with Sentance and Weale in favor of a hike.

Until now the dissenter came form among the MPC's external members, Dale is the first dissent from within the BOE itself. In some ways, the fact that Bean did not join the dissents is also hawkish in the sense that the speculation will mount that he will join the dissent next month and setting the stage for a May rate hike. Sentance also surprised the BOE-watchers by not just dissenting in favor of rate hike , but upped his call to a 50 bp move. That said, Sentance's term ends in May, so he has two more meetings to attend. Note that in recent days, the UK 2-year yield has dipped below the 2-year yield for the first time since the start of the month and is perhaps a factor stabilizing the euro against sterling.

In Asia, as we have noted, several countries have been resisting raising rates as much as the market suspects may be necessary, such as Korea, but the higher oil prices may push them. The finance minister was quoted on the news wires indicating that contingency plans are necessary to address rising prices. Malaysia reported that January prices rose the fastest since mid-2009. Singapore's inflation rose to 5.5% in January from 4.6% in December. The Monetary Authority of Singapore meets again in April and is likely to signal tighter policy. The market will likely anticipate this and bid up the Singapore dollar.

Japan surprised the market with its first trade deficit in almost two years in January. Exports rose a mere 1.4% year-over-year, just as the BOJ and the Japanese government seemed more optimistic that an export recovery is underway. It may be and could have been distorted by Lunar New Year and the slowing of exports to Asia, the weakest since late '09, would lend credence to such arguments. Disturbingly, Japan reports that exports to China rose 1% year-over-year in January, but according to Bloomberg reports, China data shows its imports from Japan have risen by 47% year-over-year. Japanese exports to the EU actually fell, though exports to the US rose, though at a slower pace than at the end of last year.